The Bank of Canada Raises Interest Rates: Here’s What You Need to Know

On July 12th, the Bank of Canada did what it hasn’t done for seven years – it raised interest rates. Economists had been speculating for weeks that Canada’s central bank would raise interest rates and that’s indeed what happened. Based on strong employment numbers and GDP growth, Bank of Canada Governor Stephen Poloz decided the time was right and hiked the overnight lending rate. It went from 0.5 percent to 0.75 percent, an increase of 25 basis points.

For years the Bank of Canada and policymakers have been warning about higher interest rates. For the most part their pleas have fallen on deaf ears. Canadians continue to pile on debt at a record pace. Today the average Canadian family owes $1.67 for every dollar of disposable income. Now that interest rates are higher, some families could run into cash flow issues. And this is only from one interest rate hike. With speculation that there could be a second interest rate hike in October, it looks like higher rates are here whether we like it or not.

How Do Higher Interest Rates Affect Canadians?

Just because the Bank of Canada raises interest rates, doesn’t mean you’ll automatically be paying more on all of your debt. It all depends on how much your lender raises prime rate (the rate your lender offers to its most creditworthy customers).

Prime rate used to always move in lockstep with the overnight lending rate. That all changed in 2015. When the Bank of Canada cut interest rates twice from the oil shock, lenders only passed along some of the saving. The overnight lending rate was cut by 25 basis points each time, but the big banks only cut prime rate by 15 basis points. This meant the banks didn’t pass along the full savings to Canadians.

Based on what happened in 2015, there was much speculation about what the big banks would do this time around with a rate hike. Would they only increase prime rate by 15 basis points or the full 25 basis points? Unfortunately, for borrowers (fortunately for the banks), the banks chose the latter, hiking prime rate by the full 25 basis points.

If you have any lending product tied to prime rate, more of your money will go toward interest and less toward principal. Your minimum payment could also go up. Lending products tied to prime rate include variable rate mortgages, student loans, lines of credit and some credit cards. The interest rate on most credit cards stays the same when prime rate changes, but there are some credit cards where the interest rate is based off of prime.

The Bottom Line

This could be the first of many interest rate hikes in the future. If Canada’s GDP growth remains strong, we could see another rate hike this year and more to come in 2018. If you have any debt tied to prime rate, now is the time to pay it down. Interest rates may be low today, but there’s no guaranteed they’ll remain low tomorrow. By taking advantage of low interest rates to pay down debt instead of getting further in debt, you can use low rates to your benefit instead of to your detriment.